Insight

Hold on! What is going on in China?

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This year China has been in the news a lot, and not always for great reasons.

A trade war hampered exports to the United States, recent diplomatic tensions further complicated relations with North American trading partners, and an economic slowdown is being harked as an indicator of a slowing global economy. Slumping sales in China have affected companies from small mom and pop shops to large multinationals like Apple and Ford. Many more are preparing for bottom line hits in the coming months, so let’s take a look at what is happening in China and how those ripple effects are affecting American companies and global FX markets.

What is happening in China?

Signs of a slowdown began to emerge in the world’s second-largest economy; housing prices began to fall, export growth halved, and auto sales declined by 16% in November alone. Along with signs of contracting consumer spending, infrastructure spending decreased dramatically in the first seven months of 2018, indicative of a slowing housing market, and by the end of July, Beijing began to take steps to induce growth and counter the slowdown. In January, the government adjusted their GDP growth target to 6%, their weakest since 1990, from “around 6.5%”.

In addition, Chinese exports contracted in December fueling concerns over a weakening economy and the FX response was not just limited to the Chinese renminbi. Our very own John Doyle, VP of Dealing and Trading, said: “the soft Chinese date sparked the sell-off and benefited the Japanese yen and at the cost of the Australian dollar.” Because China is Australia’s largest trading partner, concerns about the strength of its economy translate to bad news for the Australian dollar, the AUD lost 10% (vs the USD) in 2018 alone. The Japanese yen is historically a safe haven currency, so further bad news coming out of China can push investors towards safe-haven currencies as their appetites for risks declines. What happens in China has ripple effects felt across the globe.

That is probably why the government is fighting so hard to change course. In early January, the government made moves to inject $218 billion into the Chinese economy by lowering the reserve requirement by 1 percentage point by the end of January. When the cash reserves that banks are required to hold against their loans decreases, they can make more loans. The government is hoping that this will increase spending and drive the economy forward.

Over the summer, the central bank of China announced that it would make sure enough credit would reach companies, while the banking regulator encouraged state-controlled banks to provide abundant credit. Policies to manage the debts of local governments were rolled back, and concern is arising that the effort to free up credit will come at the expense of a worsening debt problem.

How China affects the US

A growth rate of about 6.2% of GDP is needed annually in the next two years for the communist party to fulfill their promises to double GDP and incomes in the decade to 2020. Another promise, made in January 2018, was a pledge to bring the country’s debt under control within the next 3 years, but current conditions and policies put these goals at odds with each other. Although quarterly economic figures released by the people’s party paint a picture of steady growth, American officials are quick to dismiss those “official” numbers due to the unreliability of data included in these calculations and the complexity thereof, more accurate growth figures are usually below those provided by China. This can give the appearance of a strong economy, while the experience of American companies operating in China tells a different story.

The greater Chinese market represents a major market for American companies and includes mainland China, Hong Kong, and Taiwan. As companies saw less-than-expected sales in this market, they readjusted their earnings accordingly. Apple adjusted its revenue expectation for the first time in 16 years, blaming a shortcoming in expected iPhone sales. Ford cut their full-year earnings forecast due to decreasing sales and tariff issues, the first 5 months of 2018, their Chinese saw sales down 22% and their third-quarter net income fell 37% resulting in a $378 million loss. The Chinese market represents Apple’s third largest market and Ford’s single largest, so the constriction of consumer spending is a worrying sign to shareholders who fear an economic slowdown in China is indicative of a global slowdown on the horizon.

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